UAE Economic Substance Regulations:-
The UAE Economic Substance Regulations (ESR) was first introduced in April 2019, vide Cabinet of Ministers Resolution No. 31 of 2019 concerning Economic Substance (“Old ES Regulations”). The ES Regulations were introduced by UAE as a part of its commitment to being a member of the Organization for Economic Co-operation and Development’s (OECD) Inclusive Framework and further in response to the assessment made by the European Union Code of Conduct Group on UAE’s Taxation system. The ES Regulations were majorly adopted by UAE pursuant to the global standards set by the OECD on harmful tax practices requiring companies to have substantial activities in a jurisdiction. The purpose of the ES Regulations is to ensure that the entities registered in the UAE report actual profits that are in relation with their business activity.
The Old ES Regulations duly applied to all the entities that were registered or incorporated in the UAE, including entities registered in Free zones, Financial Free zones and entities incorporated in Offshore jurisdictions. Only those entities were considered exempt wherein the government of the UAE, government of any emirate in the UAE, or any governmental authority had 51% (fifty one percent) ownership, either direct or indirect in them. Rest all entities were considered to be falling within the purview of the Old ES Regulations.
Subsequently during the month of August in 2020, the Ministry revised the Old ES Regulations and brought about certain amendments to the Old ES Regulations, vide Cabinet of Ministers Resolution No. 57 of 2020 on 10 August 2020, read with Ministerial Decision No. 100 of 2020 (“Amended ES Regulations”). The Amended ES Regulations brought about renewed clarity on the treatment of the ES Regulations, including amendments to various definitions of certain key terms as well as the scope and applicability of the ES Regulations in the UAE.
notable amendments introduced by the Amended ES Regulations were:
• Definition of a Licensee:-
In accordance with the Amended ES Regulations a Licensee is defined as a juridical person (incorporated inside or outside the UAE) or an unincorporated partnership that is registered in the UAE and that undertakes a Relevant Activity. Furthermore, a natural person, sole proprietorship, trusts, and foundations are not considered to be Licensees.
• Exempted Licensees:-
In accordance with the Amended ES Regulations, exempted Licensees mean and include entities tax resident outside the UAE, branches of foreign entities in the UAE whose income is subject to tax in a foreign jurisdiction, investment funds and an entity that isn’t part of an MNE Group with a UAE resident owner and which carries on activities only in the UAE. The exemption stipulated in the Old ES Regulations is not a part of the current exemptions list.
• Branches and their treatment:-
Branches registered in the UAE are considered to be an extension of their parent or head office and do not have separate legal personality. In case the income of the branch is being tax in a jurisdiction outside the UAE, then the ES Regulations wouldn’t apply
• Definition of a Connected Person:-
A Connected Person is defined as an entity that is part of same Group as the Licensee. Whereas a Group is defined as two or more entities related through ownership or control such that they are required to prepare Consolidated Financial Statements for financial reporting purposes in accordance with the accounting standards applicable.
• Definition of Distribution and Service Centre Business:-
In the Amended ES Regulations, distribution of goods inside the UAE pursuant to purchasing goods from a Foreign Connected Party is considered a Distribution business. Similarly providing services in the UAE to a Foreign Connected Party is also considered a Service Centre Business.
• Submission of Notification/Substance Report:-
In accordance with the Amended ES Regulations, all Notifications and Substance Declaration Reports must be submitted on the Ministry of Finance Portal.
• Filing of Notification:-
In accordance with the Amended ES Regulations, Notification must be submitted to the Ministry of Finance every 6 months from the end of the financial year.
• Penalties for non-compliance to the ES Regulations:-
The penalties for non-compliance in the Amended ES Regulations have been increased ranging from AED 20000 to AED 400000 including suspension, revocation and cancellation of licenses on account of repeated failures.
• Submission of financial reports:-
In accordance with the Amended ES Regulations, it is mandatory to submit the financial reports of the entity at the time of submission of the Substance Declaration Report.
Thus, in accordance with the ES Regulations, all Licensees (including Exempted Licensees) carrying on a Relevant Activity during a relevant financial year must Notify the Ministry of Finance (“MOF”) of the same. Those Licensees that generate an income during a relevant financial year must, in addition to Notifying the MOF provide a Substance Declaration Report within 12 months from the end of their relevant financial year.
The activities considered as “Relevant Activities” are-
· Banking Businesses
· Insurance Businesses
· Investment Fund Management Businesses
· Lease-Finance Businesses
· Headquarter Businesses
· Shipping Businesses
· Holding Company Businesses
· Intellectual Property Businesses
· Distribution and Service center Businesses
The ES Regulations stipulate that Licensees carrying on a Relevant activity for a relevant financial period and generates an income in relation to such activity must satisfy the Economic Substance Test vide the Substance Declaration Report. The test requirements are as follows-
· Whether the Licensee conducts its Core-Income Generating Activity in the UAE?
· Whether the Relevant Activity is directed and managed in the UAE?
· Whether the Licensee possesses adequate local economic substance to carry out the Relevant Activity in the UAE? which include-
1- Whether there is adequate number of qualified full-time employees present in the UAE in relation to carrying out a Relevant Activity?
2- Whether there is adequate operating expenditure incurred by the Licensee in relation to the Relevant Activity?
3- Whether there are adequate physical assets in the UAE?
A Licensee may also desire to outsource a Relevant Activity and as such must ensure the following conditions are met:-
· The Licensee must be able to demonstrate adequate supervision in the UAE,
· The outsourcing service provider must maintain adequate employees, operating expenditure and physical assets for carrying out a relevant activity in the UAE,
· The outsourced activity is conducted in the UAE, and
· The employees, operating expenditure and physical assets of the outsourcing service provider are not counted multiple times.
Fines and penalties for non-compliance are stipulated as under:-
· AED 20,000 on failure to submit a Notification.
· AED 50,000 on failure to provide accurate or complete information.
· AED 50,000 on failure to provide a Substance Declaration Report.
Fines and penalties on failure to satisfy the Economic Substance Test requirements:-
· On the occurrence of the first failure, a penalty of AED 50,000 and exchange of information with the foreign competent authority of the parent company, the ultimate parent company and the ultimate beneficial owner.
· On the occurrence of the second successive failure, a penalty of AED 50,000, exchange of information with the foreign competent authority of the parent company, the ultimate parent company and the ultimate beneficial owner, and suspension, revocation, and cancellation of licenses.
Thus, all Licensees (including Exempted Licensees) carrying on a Relevant Activity during a relevant financial year must Notify the MOF of the same and those generating an income during a relevant financial year must, in addition to Notifying the MOF provide a Substance Declaration Report within 12 months from the end of their relevant financial year.